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Acorn Partners Submission in Response to Joint Finance Canada Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:

SR & ED Program Review

Both Advantage Canada and the Science and Technology Review view Canada's entrepreneurs as modern day alchemists instrumental in the transformation of technical advances into products and services successfully sold around the world. That doubts have been publicly expressed about the capacity of Canada's entrepreneurial businesses to perform is understandable. Only one in five businesses survives a decade. Entrepreneurship like democracy is a messy process. Like democracy it is laudable only when compared with the alternatives. For both their worst excesses need to be curbed.

Firms striving to grow and dominate their market places are a minority. Only three percent of firms succeed in growing 20% a year or more. There are relatively few businesses amongst Canada's 1.5 million firms that address a market that will allow sufficient wealth creation so that the triumph of investors' greed over fear is a rational expectation. An IRR on any one transaction in excess of 50% is required at the early stage.

Worse, the reality is that only a handful of entrepreneurs are capable of building such businesses. Yet it is difficult to tell at inception whether or not an entrepreneur has the capacity to perform the work necessary to develop and implement the required business strategy. It is almost impossible to tell whether they have the potential to grow a business to the limits of its opportunity. Even if they have the raw potential, can they move from their current capacity to the level required in synchronization with the demands of the opportunity and thus meet the enormous challenges involved in high growth rates in global markets? The odds approach zero in any one instance.

It is a numbers game. Entrepreneurs of the caliber of a Gates or a Chambers are required to successfully compete worldwide. Their occurrence in any populations is a rare event. The larger the population the more likely that such a rare event will occur. Even the USA has only one Chambers one Gates.

What we as a society do not need to do is add to the barriers entrepreneurs face when struggling to achieve their potential. It is in this spirit that we have prepared the following submission. It contains recommendations on how your Ministries can act to remove barriers and thus to increase the odds of the talented few developing commercially successful products. Bluntly, we are also asking you to perform to the best of your abilities as you have asked us to perform to ours. The bumper sticker "I can do nothing: We can do anything.", has it right.

While money is not the only issue facing entrepreneurs and their investors, it is necessary. The annual level of cash flow support provided by the Program amounts to about a third of the total funds made available by the angel community segment of the capital markets. As a group these investors obtain returns which exceed Warren Buffet's. If they do not perform they run out of capital, unlike institutions.

To make the SR & ED program a world class partner for entrepreneurs and angel investors, and prevent its continuing relapse and relative decline, we have one key recommendation. Relocate the SR & ED program from the Canada Revenue Agency to the Minister of National Revenue's Office. Just as entrepreneurs must compete in global markets for products and capital, the SR & ED program needs to be competitive compared with those available in other countries.

This can only occur where a capital markets mindset prevails. This is not a reasonable expectation of CRA. Based upon direct experience over more than a decade and a half, we are convinced that the move is essential to allow the Program to perform the role it is capable of in supporting the 3 percent of firms who grow at rates of 20 plus percent per annum. Not moving it will condemn our entrepreneurs to working with a second or third rate partner, one whose future is a continued decline in competitiveness relative to other such programs around the world, one doomed to repeat the unnecessary history of episodic decline, renewal, and decline. The program concept is excellent: its implementation is not. As a result the policy can not achieve what is required. It could but it does not. We note that remedying this defect would provide a valuable demonstration project for Public Service Renewal.

Under the heading of Enhancements, we offer a number of recommendations to restore the Program's competitiveness and suggestions to reduce programs less suited to rapidly growing firms. The recommendations should not be attempted unless the program is resituated into the more receptive environment we urge upon you.

Based upon our experiences with financing millions of dollars of refundable claims for SR & ED performers across Canada, we suggest some useful rearrangements of the deck chairs. These include a specific recommendation which would have CRA cease making it possible for refund recipients to perform criminal acts. All that is required is that the Agency implements long standing common law provisions for receipt of notice in respect of assignments of commercial debt and make payments to the legal owner of the proceeds of the claim when requested. Ample precedent is incorporated in the Financial Administration Act's assignment of Crown debt provisions.

As mentioned, the SR & ED Program contributes about a third as much money to high potential companies as does the angel community, about $3 billion for the latter. It is far too important a portion of the capital market for growth driven entrepreneurs to have its implementation controlled by an organization whose mandate requires confrontation not co-operation and whose basic mindset does not take into account broader public policy matters such as the capital markets, even at the most senior levels.

We appreciate the opportunity to submit our views at a point where we have reason to believe that some in each of your organizations are in a receptive frame of mind. We would appreciate your organizations communicating their views on the material received in as open and candid fashion as the technology allows, a sign of respect for our investment of time and effort. Done appropriately, it will not require any additional effort on the part of your organizations. It will demonstrate a willingness to collaborate and avoid yet another occurrence of material disappearing into a bureaucratic black hole.

In the spirit of open collaboration amongst partners in a joint venture you have our permission make public this letter and our attached submission by posting them on the consultation website. You might consider provision of an annotation facility for submissions posted on the website?

SUMMARY

Early-stage, high-potential growth rate firms receive an estimated $3 billion per annum from angel investors. At least $1 billion more per annum is provided by the SR & ED Program. Clearly the Program is a significant contributor to the vital cash flow of these firms. Beyond that the Program serves both as a farm team for angel investors and often a co-investor. When cash refunds are made co-investing is on a cash basis.

The Program is well targeted to the 3% of SME's potentially capable of profitably selling new products world wide, the ones who invest in their business for growth: many SME's do not. Yet, to attain the objectives expressed for the entrepreneurial community in Advantage Canada and reiterated in the Science and Technology Review, the SR & ED Program cannot continue to be hosted within CRA. Its mandate is to collect, not disburse. CRA provides no support for a mindset and administration keyed to the Program's major role in the capital markets for the few but critically important entrepreneurial firms. Program design and implementation including ongoing improvements, need to be driven by the mandates set out in Advantage Canada and in the Science & Technology Review. This will only occur by relocation of the Program to an institutional setting hospitable to the Program's objective. Failure to relocate the Program will ensure the continued relative deterioration of Canada's early leadership in this field and reduce to irrelevance the Program's inherent and once unique leverage in supporting new successful Canadian entrants to the global economy.

Central Recommendation

The SR & ED program should be placed in the Minister of National Revenue's Office and the Director General should report to The Minister through a Committee chaired by the Department of Finance. Implementation of this recommendation will provide a basis for much needed ongoing innovation and process improvements.

Introduction

This submission sets out our perception of the program's key strengths and a critical weakness. Then we suggest a number of enhancements to extend the Program's design to deal with logically ancillary activities required to become commercially successful and thus achieve the goals of Advantage Canada in respect of building firms that profitably sell innovative goods and services world wide. The Enhancement section concludes with three ancillary changes to the Income Tax Act (ITA). Finally our submission suggests some administrative improvements to increase the value of the program without increasing its delivery costs to those claimants eligible to receive refunds.

Where you stand depends on where you sit. Thus we will briefly describe our role in the capital markets. Acorn Partners provides working capital products to a marketplace comprised of less than 45,000 Canadian firms with the highest growth rates. We do so in conjunction with venture capital and angel capital investors or as a lower cost alternative to these types of equity. We provide funds when it is beyond a deposit taking banks ability to do so but sometimes in conjunction with them. Occasionally we provide angel capital in a specialized form which relies on royalties on sales rather than common shares to generate returns.

Many of our clients are recipients of SR & ED refund cheques. We specialize in financing those firms most likely to introduce new products and services for sale worldwide but who have the most difficult time securing funding, in part because of the risk of loss of investors' capital and in part because of the high transactions cost relative to the amount of funds needed. The latter is at least as important a determinant of capital availability as the former in this segment of the capital markets.

Our seat provides a unique vantage point of the capital markets relevant to innovative SME's. Our observations and suggestions flow from this perspective. Our comments are rooted in our experiences with financing several millions of dollars of refundable claims across Canada.

Program Strenghts

From the viewpoint of the capital market for high potential SME's the design of the SR & ED program has several key strengths.

1. It does not attempt to pick winners. It is collaborative. The Program imposes no judgments about the market for the fruits of the SR & ED, leaving that to the entrepreneurs. Given that there is a very high level of uncertainty about the development and commercial acceptance of any product, the design nicely renders unto Caesar only what is Caesar's by avoiding attempts to pick winners.

2. Unlike conventional granting programs such as IRAP, the Program operates with a more entrepreneurial rhythm. IRAP operates within the well defined annual Parliamentary budget cycle. For the SR & ED Program, no built in government year end rush nor does a, not until the money is in the budget problem, exists. When the entrepreneur is ready the SR & ED Program can respond. For entrepreneurs, whose sources of funds are ephemeral at best, the value of this type of certainty cannot be overrated. It allows them to leverage the funds with other sources such as banks, organizations such as Acorn, and angel investors individually and in combination. This provides the capability to use many layers of financing on a small scale, a feature normally only available to large firms. This has been labeled baklava financing.

3. Not only is the taxpayer as well protected by the claim adjudication process as if the government was paying an invoice for goods or services, the claimant has to put up real cash to get the benefit. In fact the key elements of a contract are present: an offer by governments to "buy" eligible R& D and the filing of a claim which amounts to an offer to supply on the buyer's terms.

4. Finally, unlike any non-tax means available to the government, essential changes can be legislated in less than twelve months because of the tradition of annual amendments to the ITA by the Minister of Finance. This option for flexibility is valuable to all parties, as was demonstrated when the ITA was amended to make refunds assignable. Were the sector to be hard hit by adverse economic circumstances, introduction of a temporary top up could be introduced to prime the commercialization pump.

In sum, the basic design of the SR & ED program is commendable and offers a platform worthy of building upon to get the economic results the government seeks from entrepreneurs, commercially successful products sold globally. As with any human endeavour, half hearted or inept implementation assures that the results sought will not be generated. In Robbie Burns words, "(T)he best laid plans of man and mouse gang oft aglay.", and implementation not fate is the most frequent cause.

Program Weakness

One fundamental and primary weakness exists. Program implementation supportive of the policy intent is impaired by situating it deep inside an organization whose raison d'etre is to get money from reluctant tax payers, not to provide funds to willing recipients. The latter are truly clients, they have an option, filing a claim or not. Clients are to be encouraged to obtain all that the law allows but no more. Taxpayers are not clients: they have no option. They must pay all the law demands and are subject to sanctions in the criminal code for "judgment" calls on the amount to be paid. Appropriate organizational norms and values in support of effective program delivery for each role are polar opposites.

Recommendation PW-1:
To obtain policy oriented implementation, we urge that the SR & ED program be moved from the Agency to The Office of the Minister of National Revenue.

 

Proof of the merits of this recommendation lie within the program's up and down performance history. Some years ago it was turned around when a new leader was appointed from outside the Agency. Since her departure there is widespread agreement amongst firms specializing in the preparation of claims that performance has declined. From a policy perspective this deterioration has had the legislatively undesired impact of reduction of the supply of capital available to entrepreneurs.

Recruitment of skilled people is increasingly difficult for all organizations given Canada's demographic profile. This compounds the situation faced by CRA today and its impact will worsen in the years ahead. As a result of our long term underlying labour market reality, disruptive shortages of skilled financial people and technical people will persist for decades. Officials responsible for The Agency's core mandate are being asked to give up some of these hard to find, expensive to train, difficult to retain, resources for a peripheral program whose norms are the antithesis of those essential to the Agency's core mission. We find this an unreasonable expectation of officials.

To illustrate the destructive impacts of such inherent conflicts consider the RCMP experience. This same class of dilemma exists with the RCMP in respect of economic or white collar crime. Regardless of the fact that Economic Security has recently become one of the RCMP's five priorities, it is the least amongst the five priorities. There are no dead bodies. Just as the SR & ED recipients are a distinct group amongst the SME population, white collar perpetrators are as well – they are far smarter than the average criminal and have access to first rate legal counsel. Basic differences amongst two populations being served by a single organization with dominant norms mean that one is ill served. The results are now highly visible in the RCMP's case and underlie the episodic implementation problems of the SR & ED program.

Nor can such basic structural matters be easily remedied by conscientious and able individuals. High profile attempts to improve matters in the RCMP are now regarded as failures. A decade after a former RCMP Commissioner publicly stated that white collar crime was beyond the RCMP's capability no significant improvement has occurred. Today there are widespread calls for a specialized police force to align policy and implementation on this class of crime.

We believe that the evidence shows that same pattern in the SR & ED Program. Renewal is again needed for the SR & ED program to obtain the results this Government seeks. The dominant and inevitable, us and them, good guys vs bad guy's primary culture in CRA prevents development of the collaborative approaches essential to effective SR & ED Program implementation.

Recommendation PW-2:
Establish a Joint Finance, MNR Committee to Monitor The Alignment of Policy and Implementation Directives chaired by DOF and include membership by Industry Canada.

Recommendation PW3:
Primary career mobility for Officers should be a blend of experience within between DOF, MNR, ITC, CRA science based departments and industry.

None of the three recommendations in this section generates any additional program delivery costs. In fact it should reduce them.

Enhancements

That R&D leads to new products and services sold globally underpins the logic of the SR & ED program. Based upon our experiences with hundreds of SME's and our understanding of their challenges, Acorn Partners believes the Program provides a core delivery mechanism for two types of activities that are directly complementary to SR & ED: business development - a blend of marketing and sales activities which both makes early sales and, equally importantly, refines the business model to maximize profitability - and intellectual property protection. We conclude this section by suggesting some program eliminations to compensate for the increased costs of our suggestions.

Recommendation E-1:
The actual eligible amount of the first seven SR & ED claims filed by a performer be grossed up by a fixed percentage say 50% to allow for business development expenses.

To provide some assurances that the funds were indeed used for the intended purpose, the actual expenditures on the claimants P&L should be reviewed after the fourth claim to see if the amount spent is at least 75% of the top-up amount received. If not, then the amount of the actual gross-up allowed thereafter should be reduced to the actual amount spent during the claimants fourth fiscal year for which a claim has been submitted.

Sir Terry Mathews, amongst many others, states that for new entrants the costs of marketing and sales are many times the cost of a product's R&D. R&D is just the price of entry to the playing field. Sales and marketing costs are the costs of playing the game. and being a contender. While much of the latter costs occur after the R&D has been performed some should be undertaken early in the cycle to focus the R&D activities on customers' pain points. This need occurs at a time when raising additional capital is most difficult for firms , in large part because of the relative size of the transaction costs involved. The risk may often be a secondary consideration.

Recommendation E-2:
Allow claimants to include the costs of intellectual property protection as an eligible expense.

Amidst the clamor for cash endemic to most early stage firms, protection of intellectual property is all too often neglected by claimants. Yet the value of intellectual property protection is well recognized. Cognos, for example, has a procedure to link claims preparation to IP protection activities.

The availability of private sources of funding, such as angel and venture capital, is almost always contingent on the existence of adequate protection of intellectual property for core technology. Without assisting companies doing business in Canada in this regard, the ability to secure private funding could be severely limited. Conversely, should proper protection of intellectual property be available, additional opportunities for private funding will be made available by virtue of the Program. Even where external equity capital is not warranted or sought, intellectual property protection improves the survival odds of the firm allowing it to continue to grow and prosper.

In addition, the ability for Canadians to control their own innovation lags far behind that of other countries. The Organization for Economic Co-operation and Development recently showed that less than 15% of the patent applications filed at the Canadian Intellectual Property Office were in the name of Canadian applicants (The Compendium of Patent Statistics 2007, OECD). This number pales in comparison to other national and regional patent offices, where domestic applicants accounted for at least 40% of the filed applications (and typically much more in most Patent Offices). As this clearly demonstrates, innovative technology used in Canada is increasingly developed, owned and controlled by companies located outside of Canadian borders. The Program affords an ideal opportunity to reverse this trend and put innovative technology back in the hands of Canadian companies and entrepreneurs, for the benefit of all Canadians.

Finally, the intellectual property regime, like the Program, is intended to promote scientific and technological endeavours by rewarding innovators. By providing Canadian companies and entrepreneurs access to this reward by including the costs of protecting their innovation, the Program further encourages R&D activity to take place in Canada.

Recommendation E-3:
Withhold one tenth of one percent of the allowed value of each claim when the claimant has sales of less than $250 million dollars per year and remit it to an intellectual property litigation fund available to all such claimants.

In part neglect of spending money on intellectual property is "justified" by the entrepreneurs realization that even if they have a well thought through protection strategy, its only real value lies in being able to defend it or enforce it in multiple levels of courts here and abroad. This, early-stage cash-poor firms cannot do. Investors also realize that the costs of defence are beyond their means and act accordingly: the prudent keep their cash in their pockets.

Recommendation E-4:
Institute an Initial Customers Program for Federal Procurement of innovative goods and services supplied by claimants and of value to one or more government departments or agencies use the SR & ED program as the payment mechanism.

Federal government procurement in North America has small business set asides but there is no set aside for the critical segment of potentially high growth rate firms bringing innovative goods and services to market. For them one of the most valuable assets is a handful of key initial customers. "If your government won't buy from you why should we?", is a barrier to sales that admits of little constructive reply. The Deputy Minister of Public Works forwarded a letter from us dated November 1, 2005 to the Deputy Minister of Finance which outlines in more detail the benefits to the government and the claimants of such a program and how it would work for SR & ED performers.

Ancillary Complementary Changes To The ITA

There are four changes to the Income Tax Act that would enhance the prospects of claimants successful commercialization of the results of investments in R&D by increasing the availability of capital to them from the angel community.

Recommendation ACC-1:
Change the tax free rollover provision for the proceeds of the sale of shares in a CPCC from a six month window to one of payment of tax when it would otherwise be due but allow either a rebate of the tax paid or a credit against taxes otherwise payable for subsequent investment in a CPCC or a tax refund at the time of investment. Both should be exempted from the alternative minimum tax provisions.

Recommendation ACC-2:
Allow royalty payments to those investing in technology firms to be treated as capital gains when there is a risk of loss of capital as there is with common shares.

Recommendation ACC-3:
Correct a policy oversight that occurred when the revenue and expenditure "matching rules' in respect of limited partnership structures were introduced.

To correct what was an abusive use of limited partnership structures in the movie industry, which then allowed flowing loses to investors when the general partner had no income in the period, the government introduced a rule in 1997 that requires that revenues and expenditures be matched in time periods, the so called matchable expenditures rule. It introduced a prorating of the expenditures over the life of the right to receive income. Prior to their introduction, we had used them to raise a modest sum of angel capital - $300,000 - for a firm which subsequently introduced a product and related services that met every objective of Advantage Canada in respect of entrepreneurs building on R&D.

Following our inquires with tax practitioners and officials in the Department of Finance it became clear to us that the destruction of the equivalency with the USA LLC had not been taken into account in the decision to introduce the matching rules. While driven by a need to restore Canada to financial solvency a decade ago, there was collateral damage from the adverse impact on the size of the pool of capital available for early stage firms. While it is now possible under the current regime to purchase common shares in a CPCC and then, following the expenditure of the invested funds, possibly be able to declare the firm insolvent and thus obtain a tax deduction, there is a significant timing difference and uncertainty for investors compared to the prior regime. A "cash refund" at the time of the investment provides much better motivation to invest than the same three years latter.

We believe that Advantage Canada's objective would be better achieved by allowing both options. Because the amounts invested are modest, typically around $500,000 the financial reality differs significantly from that which prompted the rule's introduction, Hollywood millions per deal. Limiting the matching rules in respect of R&D performers would not re-create the situation which had lead to the introduction of the rules in a time of government financial crises. This has long since passed and the Governments actions in respect of the commercial exploitation of science show that the challenges today are providing capital to entrepreneurs for investment in our future.

Recommendation ACC-4:
To increase the impact of IRAP, retain the grant approval process but allow SR & ED recipients the option of receiving payments from NRC subject to their annual appropriations or via adding the amount of their grant less the current level of reduction in the value of the claim to the annual SR & ED claim.

SR & ED claimants who are also IRAP recipients are firms that are only temporarily small, very temporarily small. Perverse incentives of the sort introduced by the Parliamentary annual budget cycle imposed on IRAP are not needed. Nor are they of value to the taxpayer.

Recommendation ACC-5:
Were all of the immediately above recommendations to be accepted, we suggest that the SR & ED recipients not be allowed to participate in the PEMD program which supports international marketing, the insured business loan program for the acquisition of physical assets, or the preferential tax rates on profits for small businesses.

The larger opportunity to improve our productivity is to focus on a tax structure that by facilitation of access to non debt capital supports a drive to profitable global sales. The impact of adoption of the above set of recommendations is also a constructive response to the National Angel Organization's long standing request for a tax credit to the investor. As angel investors and a founding member of the NAO, Acorn prefers these recommendations to the tax credit used in BC for the same reasons we prefer the structure of the SR & ED Program to that of IRAP: the former better matches the rhythm of entrepreneurial drive.

Program Administration

Acorn Partners does not assist firms in the preparation of SR & ED claims, although we have them reviewed by highly qualified external consultants prior to buying the right to the proceeds from claimants. By common law they are limited to selling the value of the payment they would otherwise receive. Because they can only sell the right to the funds they would otherwise receive, it is a buyer beware situation. Thus a sale will only occur when the claimant (seller) has made a business judgment that receipt of the funds prior to the filing of the claim or its payment allows them to pursue wealth creating opportunities that generate more than enough value to pay for the cost of funds. Some of our clients have received venture capital, others angel capital, but most are bootstrapping. All have concluded that the value they expect to create from immediate access to their funds and use to fuel their drive to market far exceeds the cost of obtaining them. Thus our observations on program administration are tied to the vantage point of financiers rather than preparers. Five recommendations and supporting commentary follow.

Recommendation PA-1:
Remove the where performed restriction on eligible costs provided the resultant intellectual property and the capacity to exploit it resides within the minds of people who are employees of a Canadian firm paying payroll taxes in Canada for the individuals whose salary costs or contract payments are part of the claim.

We have observed that there are occasions where the best "lab" for technical staff is the customer's site. The activity is performed by Canadians whose firm is paying payroll taxes and the benefit resides in the minds of these individuals and their firm regardless of where some activities where performed. Disallowances thwart the intent of the policy underlying the SR & ED Program as expressed in Advantage Canada and the S&T Review.

Recommendation PA-2:
Where CRA has disallowed a claimed activity for scientific reasons and if a patent agent provides an opinion that the result of the activity is patentable, allow the activity and its costs.

One of the inherent difficulties facing the sound implementation of the Program's intent lies in the wide range of technical activity in which Canadian entrepreneurs engage, a reflection of our diversity of means of creating wealth in our economy. Knowledgeable response depends on the technical capacity of CRA and its consultants. Use of patent agents with the appropriate subject matter technical training as an expert reviewer would improve the claimant's ability to know whether or not the disallowance was correctly disallowed on a timely basis. It would also dispel any appearance of lack of independence of CRA's appeal process.

Recommendation PA-3:
When CRA disallows a portion of a claim, immediate payment of the allowed amount should occur. There should not be any attempt on the part of CRA to bargain with the claimant to accept the lower amount in exchange for prompt payment.

We are aware of instances where clients have been asked to accept a reduction in the amount claimed as the price of getting a cheque issued. This is wrong and an abuse of power by CRA. The practice provides an excellent insight into the pervasiveness of the money intake culture of CRA. When CRA officials take advantage of the imbalance of power between CRA and a claimant the official deprive the claimant of their right to appeal. Given that the purpose of the program is to encourage the performance of SR & ED activities it is counter productive.

Recommendation PA-4:
CRA should cease to put claimants in the position of having to guess what the rules are by releasing internal directives which govern how the program operates such as SR & ED 99-01.

Under the ATI this information has to be released and following vigorous prosecution of the request has been to us. Two different versions were obtained. Each had differing items redacted. Nothing so clearly illustrates CRA's anti-collaborative mindset, the auditors standard, us versus them, got-you mindset. Indeed not freely providing such information gave us a clear impression of a retreat from the rule of law to secret law, a mode of operation which was turned back some centuries ago in common law.

Recommendation PA-5:
CRA should use the long-standing existing process under the Financial Administration Act to accept notice of a request to redirect the amount otherwise due to the claimant {assignor} of an SR & ED payment to the financier {assignee} in the latter's name - whether payment is by cheque or by electronic means - when requested by both parties, that is notice is given to the Crown by means of an absolute assignment between claimant {assignor} and financier {assignee}. {An absolute assignment transfers property rights in the proceeds of the claim to the financier.}

From the inception of the Program, successive governments have agreed that annual SR & ED refunds can be financed by third parties. Claimants paying corporate income taxes or GST get a tax credit when they file their taxes, often quarterly. Third party financing allows the Program to provide roughly equal cash flow treatment for all claimants, annual refunds that can be financed or cash in the firm from quarterly reductions in the amount of tax paid. Third party financing occurs only for claimants obtaining refunds and thus offers a measure of protection to taxpayers as well by demonstrating that others are satisfied with the quality of the claim.

Assignments of SR & ED claims were without force in law as a byproduct of a Supreme Court decision. Following the decision, lenders refused to continue lending to annual refund recipients. However, the government wanted performers to continue to access financing from third parties. Legislation making SR &ED refund payments assignable was hurriedly introduced by an amendment to the ITA. It could have been done as expeditiously by issuance of a regulation under the FAA which was the correct approach based upon legal precedent.

It is worth noting that Ontario, which does redirect payments in the name of the financier and operates under a Financial Administration Act that is modeled after the Federal one, does not have the same fears CRA has expressed to us. Like CRA, Ontario has rights of set-off, for example in respect of Provincial Sales Tax. Such rights are not compromised by redirection of payment and cannot be in law. The financier is paid only what would have otherwise been paid to the claimant. This has been the long standing practice under the Federal Financial Administration Act when the Receiver General is notified of an assignment. In short, we believe CRA's fears are groundless arising from an originally hurried decision.

The result is that the current mechanism does not accomplish the legislative aims of the SR & ED Program and reduces the number of investors willing to supply funds and hence the amount of credit available to aggressive entrepreneurs.

Recommendation PA-6:
The 'care of option" invented by CRA should be modified so that a claimant can only cause CRA to modify the instruction in the assignee's favour upon provision of the written consent of both parties. CRA should be required to verify the information supplied by the claimant in such cases.

When the amendment to the ITA allowing refunds to be assigned was first passed, CRA dealt with the fact that the government policy as legislated wanted third party financing to occur. It chose to deal with the reality that financing organizations need to have some control over the payment resulting from a claim they have financed by creation of the "care of option". It is akin to a lock box mailing address, a concept some times used by financiers. The key to the box resides with the financier. But CRA's implementation is fundamentally flawed: CRA provides the claimant a key. Even as a response to a lending arrangement, where assignment is by way of a security interest and the name of the payee is not altered, CRA 's response fails to protect those who have advanced funds. It is useless because claimants can unilaterally modify it at will and do. Beyond that it is clumsy, all mail is redirected not just cheques and often must be redirected again to the taxpayer. This implementation of the care of option poses a significant and totally unnecessary monitoring burden on the financier. The care of option also reduces the number of lenders willing to supply funds and restricts those who to whom they will lend. As well it increases the cost to all entrepreneurs.

Payment by electronic means was not contemplated when the care of option was created and its introduction has made a poor situation worse. Now it is possible for a claimant to accede to the "lock box" and then subsequently request electronic payment deposit: they have the key. We have had such an experience. No way exists to enforce the intent of the care of option, save obtaining an injunction against CRA and the taxpayer at a cost of thousands of dollars to all parties. Again in the name of taxpayers' rights, by not taking appropriate action in respect of electronic payments, CRA makes it possible for claimants to avoid their legal obligations to those who have advanced money. The same pernicious impacts occur as with cheques.

If the Government wants the private sector to deliver, persistent administrative practice should support, not detract from, attainment of Advantage Canada's objectives. The organization delivering the SR & ED program must see itself as a player in the capital markets subject to normal commercial rules and disciplines.